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Letter Ruling

Letter Ruling Letter Ruling 18-3: Energy Storage System used at Photovoltaic Electricity Generation Facility

Date: 08/05/2018
Referenced Sources: Massachusetts General Laws

Table of Contents

I. Introduction

You request a letter ruling on behalf of ____________ (“Lessee”) regarding the Massachusetts sales and use tax treatment of: 1) the purchase and lease of eight items of tangible personal property that will comprise an energy storage system to be used in connection with a photovoltaic electric generation facility, and 2) software to be used in the operation of the energy storage system.  You state the facts as follows:

II. Facts

A.  The Project

Lessee is a Delaware limited liability company that has a principal place of business in Massachusetts. Lessee is a wholly-owned indirect subsidiary of ____________ ("Parent"), a Delaware corporation.  Parent and Lessee are in the business of operating power plants.  Lessee currently operates, through the services of an affiliate pursuant to an operation and maintenance agreement, an approximately "X" megawatt direct current solar photovoltaic electric generation system (the "PV System") located ____________ in _____, Massachusetts (the "Operating Plant").  The PV System is intended to deliver 100% of its net electric generation to ____________ ("Utility Co."), a municipally-owned utility company. Utility Co. owns and operates the electric distribution system within ____________ (the "City") and provides electric distribution service and electricity supply services to all electricity customers in the City.

Lessee became the lessee of the PV System through a sale-leaseback transaction, pursuant to which Lessee sold the PV System to ____________ ("Lessor"), a Delaware limited liability company, and immediately leased the PV System back from Lessor.  Lessor is not an affiliate of Parent or Lessee.  Lessor and Lessee intend, for federal income tax purposes, that Lessor be treated as the owner of the PV System and that the lease between Lessor and Lessee be respected as a true lease.

Lessee intends to purchase from ____________, a Delaware limited liability company and affiliate of the Lessee (the "Installation Service Provider") the equipment and services necessary for the design and installation at the Operating Plant of a lithium-ion battery-based energy storage system (the "Energy Storage System"), as well as certain ongoing operational support services. The Energy Storage System will have the capacity to store and discharge and deliver to Utility Co. up to "X" kilowatts and "X" kilowatt-hours of electric energy.  The Installation Service Provider will procure all equipment and installation services necessary for the installation of the Energy Storage System at the Operating Plant.  Upon completion, Lessee will own the Energy Storage System.  Shortly after Lessee acquires ownership of the Energy Storage System, Lessee will sell the Energy Storage System to Lessor and immediately lease the Energy Storage System back from Lessor in a sale-leaseback transaction.  Lessor is not an affiliate of the Installation Service Provider.  Lessor and Lessee intend, for federal income tax purposes, that Lessor be treated as the owner of the Energy Storage System and that the lease between Lessor and Lessee be respected as a true lease.

The Energy Storage System will be electrically connected and wired together with the PV System and Utility Co.’s distribution system (the “Project”).  In this way, once Lessee has integrated the Energy Storage System into the PV System and interconnected both systems to the Utility Co.’s distribution system, Utility Co. will be able to request that Lessee discharge stored solar energy when it is most valuable to Utility Co.’s customers and Utility Co.’s distribution system, thus optimizing the electricity that is generated by the PV System.  The equipment and wiring will be installed between and among the PV System, Energy Storage System and Utility Co.’s distribution system permitting the operation of each in parallel with the other.

The Energy Storage System also will be capable of storing electricity drawn from Utility Co.’s distribution system during periods when the PV System is unavailable or the available solar energy resource is inadequate in order to ensure that the Energy Storage System is sufficiently charged to be able to satisfy Lessee's obligations to deliver electricity to Utility Co.  Utility Co.’s distribution system will receive power from the Energy Storage System for the subsequent delivery to its customers during peak periods.  Accordingly, the Energy Storage System will operate harmoniously with the Project as an integrated and synchronized electricity furnishing system, and will not be used other than to provide energy to Utility Co.’s distribution system.  Other than during outage periods when it may be taken offline for purposes of routine or unexpected service and maintenance, the Energy Storage System will be in constant operation:  it will either be charging, discharging or maintaining its state of charge.

B.  Property for Which Exemption is Sought

      1.  Items Incorporated into Energy Storage System

The Energy Storage System will be comprised of the following components:

a)  an assembly of lithium-ion batteries;
b)  protective containers to house the batteries and other Energy Storage System components;
c)  inverters to convert power between direct current and alternating current;
d)  transformers to transfer electricity between Utility Co.’s electric distribution network, the PV System and Energy Storage System;
e)  heating ventilation and air conditioning equipment to maintain the proper climate for the operation of the Energy Storage System;
f)  electrical interconnection equipment for the interconnection of the Energy Storage System to Utility Co.’s electric distribution system;
g)  meters and related electric metering equipment to measure the charging, discharge and delivery of energy from the Energy Storage System; and
h)  controllers for the operation of the Energy Storage System by Lessee.

      2.  Software Incorporated into Energy Storage System

The software to be used in the operation of the Energy Storage System (the "Software") will be licensed to Lessee by the Installation Service Provider.  The Software will consist of two main products: the controller software, which will be deployed on the Energy Storage System's controllers, and cloud-based software, both of which will be critical to the operation and management of the Energy Storage System.  The Software will provide the capability to monitor and control the Energy Storage System locally or remotely.  The Software will be used to control the discharge of the battery, including the amount of power and duration of the discharge, and will have a user interface application on the controller to allow the operator to schedule dispatch of the battery locally in the event that connectivity with the cloud-based software is lost.  The Software also will be able to read and understand the state of charge, overall asset health and any operating anomalies. 

The Installation Service Provider's base software system, ____________ (“Base Software System”), was developed, and has been used, solely for behind-the-meter use, including such customer services as peak shaving (i.e., reducing consumption of energy drawn from the grid during periods of peak demand by discharging energy from the battery for consumption by the customer).  The user of the Base Software System is able to monitor the energy usage profile of a customer's facility and, in response, optimize the charging and discharging of the battery based on the customer's objectives.  Using a forecast for the customer's facility that is generated every "X" minutes through the Base Software System, the user of the software is able to optimize the function of the battery to improve performance and adapt to weather and workflow changes.

The Installation Service Provider is using its Base Software System to create the Software for use by Lessee in furnishing electricity to Utility Co.  You state that the capabilities of the Software differ substantially from the behind-the-meter services provided by the Base Software System.  In particular, Utility Co. will be able to utilize a web­based portal to communicate with the Lessee to schedule, modify and request energy storage services from the Lessee as part of its power purchase agreements with the Lessee. Utility Co. will forecast the wholesale energy market and transmission peak demand events, as well as wholesale market arbitrage events, and request, through the web-based portal, that the Lessee discharge stored energy to it during specific days and hours to reduce load on its distribution system.  Using the Software, the Lessee will be able to collect and make available to Utility Co. information and metrics related to the performance of the Energy Storage System, including without limitation relative charging amounts from the PV System and the Utility Co.'s distribution system, forecasted charging amounts from the PV System, the state of charge of the Energy Storage System, amounts of energy delivered, discharge amounts, battery degradation and round-trip efficiency.  The Software's reporting metrics will also be used by the Lessee for federal tax credit reporting compliance.

III. Issues

1.   Whether, for purposes of G.L. c. 64H, § 6(s), the items listed in Section II.B.1., clauses (a) through (h), qualify as machinery that is used directly and exclusively in furnishing electricity that is delivered to consumers  through mains, lines or pipes.

2.   Whether, for purposes of G.L. c. 64H, § 1, the Software described in Section II.B.2. is custom computer software and is therefore exempt from sales tax.  Alternatively, whether, for purposes of G.L. c. 64H, § 6(s), the software, regardless of its characterization as custom or standardized software, is exempt as an adjunct to and incorporated into exempt machinery used directly and exclusively in furnishing electricity that is delivered to consumers through mains, lines, or pipes under G.L. c. 64H, § 6(s).

3.   Whether Lessee's sale of the Energy Storage System, including the Software integrated into the System,  to Lessor is exempt from sales tax as a casual and isolated sale under G.L. c. 64H, § 6(c); and additionally, whether Lessor’s subsequent leaseback of the Energy Storage System to Lessee is exempt from sales tax under G.L. c. 64H, § 6(s).

IV. Rulings

1.   For purposes of G.L. c. 64H, § 6(s), with the exception of protective containers described in Section II.B.1.(b) the items listed in Section II.B.1., clauses (a) and (c) through (h), qualify as machinery that is used directly and exclusively in furnishing electricity that is delivered to consumers  through mains, lines or pipes.  Therefore, (A) Lessee's purchase of this equipment from the Installation Service Provider is exempt from sales tax; (B) Lessee's sale of this equipment to Lessor is exempt from sales tax; and (C) Lessee's lease of this equipment from Lessor is exempt from sales tax.

2.   For purposes of G.L. c. 64H, § 1, the Software described in Section II.B.2. is standardized (or prewritten) computer software.  Therefore, Lessee's license of the Software from the Installation Service Provider is subject to sales tax, unless exempt under another provision of law.  In this instance, we find that the Software is exempt from sales tax because it is an adjunct to and incorporated into the exempt machinery that is used directly and exclusively in furnishing electricity that is delivered to consumers through mains, lines, or pipes under G.L. c. 64H, § 6(s).

3.   Lessee's sale of the Energy Storage System to the Lessor is exempt from sales tax as a casual and isolated sale under G.L. c. 64H, § 6(c). Furthermore, Lessor’s subsequent leaseback of the Energy Storage System to Lessee is exempt from sales tax under G.L. c. 64H, § 6(s).

V. Discussion

A.  Purchases of Items Incorporated into the Energy Storage System

Massachusetts imposes a 6.25% sales tax on all retail sales in Massachusetts, unless otherwise exempt.  G.L. c. 64H, § 2.  The exemptions from sales tax are found in G.L. c. 64H, § 6.  Under G.L. c. 64H, § 6(s), sales of machinery or replacement parts used directly and exclusively in "the furnishing of gas, water, steam or electricity when delivered to consumers through mains, lines or pipes" are exempt from sales tax ("the furnishing clauses").[1]  To be exempt under the furnishing clause of G.L. c. 64H, § 6(s), each item incorporated into the Energy Storage System must meet all of the following requirements: It must be 1) machinery; 2) used directly and exclusively; 3) in the furnishing of gas, water, steam or electricity; 4) when delivered to consumers; 5) through mains, lines, or pipes. 

1.  "Machinery"

For purposes of G.L. c. 64H, § 6(s), the Massachusetts Supreme Judicial Court (SJC) has defined "machinery" as "any combination of mechanical means designed to work together so as to effect a given end."  Warner Amex Cable v. Board of Assessors, 396 Mass. 239, 242 (1985).  Machinery has been further defined to include not only the basic unit but also any adjunct or attachment necessary to accomplish the intended function of the basic unit. Western Electric Co., Inc. v. Commissioner of Revenue, A.T.B. Docket No. 113779 (1984). It also includes all devices required to control, regulate or operate a piece of machinery, provided such devices are directly connected with or are an integral part of the machinery and are used exclusively for such purposes.  Id.

The Commissioner has applied this analysis to various fact patterns under the furnishing clause of G.L. c. 64H, § 6(s).[2]  While the furnishing clause may exempt a broad range of machinery, it is not without limits.  For example, the Commissioner has ruled consistently that items of tangible personal property used by a contractor or its subcontractors in fulfilling their obligations under a contract that do not become part of the electricity furnishing apparatus are not exempt from tax; a contractor and its subcontractors are considered the users of the property, and are liable for the tax on such items. Such items would include machinery and replacement parts, materials, tools and fuels that are not physically incorporated into the plant or are not used in the actual furnishing of electricity, or that are consumed and used before the project begins furnishing electricity to consumers.[3]

With the exception of the protective containers to house the batteries described in Section II.B.1.(b), the items listed in Section II.B.1. qualify as machinery for purposes of the furnishing clause because they represent a "combination of mechanical means designed to work together so as to effect a given end,'' as described in  Warner Amex Cable. The particular "end" in this case is the storage of energy for subsequent distribution to the Utility Co.’s electric distribution system that, in turn, furnishes electricity to consumers.

2.  "Used Directly and Exclusively"

The Commissioner has previously addressed the "directly and exclusively" requirement under various clauses of G.L. c. 64H, §§ 6(r) and (s) in a number of public written statements.[4]  As the Commissioner has noted, "[i]t is not practical to divide a generating plant into 'distinct' stages.  It was not built that way, and it does not operate that way. The words 'directly and exclusively' should not be construed to require the division into theoretically distinct stages of what is in fact continuous and indivisible."  Letter Ruling 05-2.  With the exception of the protective containers described in Section II.B.1.(b), the items described in Section II.B.1 meet this requirement of the exemption because they are used directly and exclusively in the overall process of furnishing electricity to consumers.  The containers do not satisfy this requirement because they function as protection for other parts of the system and are not directly involved in the furnishing of electricity.

3.  "Furnishing of Gas, Water, Steam or Electricity"

In evaluating whether an item of property is exempt from sales tax under the furnishing clauses of G.L. c. 64H, § 6(r) and (s), the SJC has not required that the item itself actually furnish the gas, water, steam or electricity. Instead, the SJC in Lowell Gas Co. v. Commissioner of Corporations and Taxation, 377 Mass. 255 (1979) applied what it described as the functional approach set forth in Niagara Mohawk Power Corp. v. Wanamaker, 286 App. Div.(N.Y.) 446, 449 (aff'd) 2 N.Y. 2d 764 (1955) and Courier Citizen Co. v. Commissioner of Corps. & Taxation, 358 Mass. 563, 579 (1971), which focuses in part on the following question: "Does the disputed item operate harmoniously with the admittedly exempt machinery to make an integrated and synchronized system?"  The SJC acknowledged that "[w]hile the courts in Niagara Mohawk Power Corp. and Courier Citizen Co. were interpreting provisions exempting from sales tax equipment used in production, and manufacturing, respectively, the functional analysis employed in those cases for determining which items warranted exemption is no less applicable to the furnishing clause."  Lowell Gas, 377 Mass. at 263, footnote 9.  The SJC in Lowell Gas found that pipes, meters, production, storage and pressure regulating equipment were all integral components required in the company's system, and were all exempt from sales and use tax as machinery used directly and exclusively in the furnishing of gas.  Equipment that stores gas, water, steam or electricity that is to be delivered to consumers through mains, lines or pipes has been determined by the Commissioner to be part of the "furnishing" process. 

The Department of Revenue has previously determined that storage equipment can qualify for the sales tax exemption under G.L. c. 64H, § 6(s).  In Letter Ruling 05-2, both raw and treated water tanks to be used in a water desalination plant were determined to be exempt from sales tax under G.L. c. 64H, § 6(s).  The ruling describes the purpose of the raw water tank as being to allow flow equalization and to allow a constant flow rate when there is no salinity in the river.  The treated water tank is used to store treated water prior to delivery to the city for distribution to consumers.  Because the tanks became part of the integrated and synchronized system, or machine, that furnishes water to consumers, they were considered exempt.  Like the items discussed in Letter Ruling 05-2, the items at issue here are also part of an integrated and synchronized system, or machine, that is used in furnishing electricity to consumers.  They are critical for the optimization of the use of the intermittent and variable power produced by the PV System, allowing for the better control and regulation of the delivery of energy to Utility Co.’s distribution system.  

By integrating the Energy Storage System with the PV System, and interconnecting these integrated systems to Utility Co.’s distribution system, Lessee is able to provide Utility Co. with energy output at times and in quantities that the PV System, without storage capacity, would not be able to provide. As the distribution network owner and operator, and the supplier of power for the City, Utility Co. is obligated to coordinate the supply of electricity with the demand for electric power within its territory, in real time, every hour of every day of the year.  Because it is a variable generation resource that is wholly dependent on the solar energy provided by the sun, the PV System cannot be dispatched or controlled to generate electricity at times when Utility Co. electricity from other sources may be in low supply or in high demand.  

We conclude that with the exception of the containers described in section II.B.1.(b), the remaining items that are incorporated into the energy storage system satisfy the “furnishing” requirement because they operate harmoniously as part of an integrated and synchronized system for furnishing electricity to Utility Co., which, in turn, furnishes electricity to consumers. The containers do not satisfy this requirement because they function as protection for other parts of the system and are not directly involved in the furnishing of electricity.

4.  "When Delivered to Consumers"

In order for the items described in Section II.B.1 to be exempt from sales tax under the furnishing clauses of G.L. c. 64H, § 6(r) and (s), the electricity generated by the Project must be “delivered to consumers.”  The Commissioner has previously addressed the “delivered to consumers” requirement in a number of letter rulings, with the conclusion in each ruling being highly dependent on the facts.[5]  Here, we conclude on the facts presented that the Project’s operations meet the requirement of furnishing electricity to consumers because the Energy Storage System, which is inter-connected with the PV System, is delivering electricity to Utility Co., which in turn provides electric distribution service and electricity supply services to all electricity customers in the City.

5.  "Through Mains, Lines, or Pipes"

In order for the items described in Section II.B.1 to be exempt from sales tax under the furnishing clauses of G.L. c. 64H, § 6(r) and (s), the electricity generated by the Project must be delivered “through mains, lines or pipes.”  The SJC has recognized that the phrase "through mains, lines, or pipes" is intended to distinguish entities that employ main, line or pipe delivery systems from those that use other delivery systems, such as bottling systems. See Lowell Gas, 377 Mass. at 259.  "As long as [gas] is ultimately delivered to consumers through mains, lines or pipes, as opposed to some other delivery system, the statutory requirement is satisfied." Id.[6]  The Project satisfies this requirement because it delivers electricity through lines.

B.  Purchases of Software Incorporated into the Energy Storage System

      1.  Standardized v. Custom Software

Massachusetts imposes a 6.25% tax on sales by any vendor within the Commonwealth of tangible personal property, which includes standardized (also called “canned” or “prewritten”) software regardless of the method of delivery, and software upgrades.  G.L. c. 64H, § 2; 830 CMR 64H.1.3(3)(a), Computer Industry Services and Products.  The sale, license, lease or other transfer of a right to use software on a server hosted by the taxpayer or a third party, as described in 830 CMR 64H.1.3(3)(a), is generally taxable.  However, where there is no separate charge for the right to use the software and the object of the transaction is the acquisition of a good or service other than the use of the software, sales or use tax generally is not imposed.  830 CMR 64H.1.3(14)(a). 

Sales of custom software are generally exempt from sales tax as professional service transactions regardless of the method of delivery.  830 CMR 64H.1.3(6)(a); TIR 05-15 (Transfers of Prewritten Computer Software).  Custom software is defined in 830 CMR 64H.1.3(2) as "a software program prepared to the special order of a customer that is not `prewritten software.”  Pre-written software, in turn, is defined as

computer software, including prewritten upgrades, which is not designed and developed by the author or other creator to the specifications of a specific purchaser. The combining of two or more prewritten computer software programs or prewritten portions thereof does not cause the combination to be other than prewritten computer software. Prewritten computer software includes software designed and developed by the author or other creator to the specifications of a specific purchaser when it is sold to a person other than the specific purchaser. Where a person modifies or enhances computer software of which the person is not the author or creator, the person shall be deemed to be the author or creator only of such person's modifications or enhancements. Prewritten computer software or a prewritten portion thereof that is modified or enhanced to any degree, where such modification or enhancement is designed and developed to the specifications of a specific purchaser, remains prewritten computer software; provided, however, that where there is a reasonable, separately stated charge or an invoice or other statement of the price given to the purchaser for such modification or enhancement, such modification or enhancement shall not constitute prewritten computer software." 830 CMR 64H.1.3(2).  Charges for installation and/or configuration of custom software are also generally not taxable.  In addition, sales of custom modifications to prewritten software are generally not taxable if the sales price of the prewritten software and the charges for the custom modification are separately stated.  830 CMR 64H.1.3(6)(d). 

The Base Software System is available to other customers besides Lessee.  The fact that the Base Software System is further configured to adapt to the specific needs of each customer, such as by making adjustments for optimizing battery charging and discharging, does not transform the prewritten Base Software System into custom software.  Software that has been designed with built-in options or capabilities that may or may not be accessed or utilized by a customer is prewritten software.  Prewritten software that is modified or enhanced to the specifications of a specific customer, remains prewritten software. 

We do not find that the facts as you have presented support the contention that the software at issue is custom software under 830 CMR 64H.1.3(2).  Rather, the Installation Service Provider is combining two or more prewritten software programs or prewritten portions of its software to form a software platform that is “personalized” to meet the needs of each of its customers.  The personalization of software to fit the needs of a particular customer does not transform the software into custom software.[7]

            2.  Software as an Adjunct to Exempt Machinery

The Commissioner has not ruled specifically on the question of whether software used in connection with the operation of an energy storage system can qualify as "machinery" within the meaning of the "furnishing clause" of G.L. c. 64H, § 6(s).  While the Commissioner has not addressed the question of whether software can, on its own, qualify as “machinery” within the meaning of the furnishing clause, software could still be exempt as an “adjunct” to the basic unit of machinery under the theory set forth in Western Electric. Letter Ruling 10-3 applied that theory to the machinery and components used in constructing a wind turbine under G.L. c. 64H, § 6(s), and concluded that a wind turbine qualified as "machinery" used directly and exclusively in the furnishing of electricity to consumers through mains, lines, or pipes.  The ruling further concluded that a tower, its components and foundation also qualified for exemption since they were either adjuncts or attachments necessary for the wind turbine to accomplish its intended function or, alternatively, are used to control, regulate or operate the wind turbine.  See also Letter Ruling 10-4, utilizing the same analysis with respect to the application of the § 6(s) "furnishing clause" to purchases of anaerobic digesters used, in part, to produce electricity for use in dairy farms in Massachusetts. Here, we find that the Software at issue qualifies as an "adjunct" to the exempt machinery that is the Energy Storage System.  However, in order to be exempt under the furnishing clause of G.L. c. 64H, § 6(s), the Software must meet the additional statutory requirements of section 6(s), including being used "directly and exclusively" in furnishing electricity to consumers through mains, lines, or pipes. 

3.  Software Used Directly and Exclusively in the Exempt Electricity Furnishing Activity

The Commissioner has already addressed whether the Energy Storage System itself is used directly and exclusively in furnishing electricity to consumers in Part V.A. 2. and 3, above. The same principles referred to in those sections apply for purposes of evaluating whether the Software used in connection with the Energy Storage System is used directly and exclusively in the furnishing of electricity under the furnishing clause of G.L. c. 64H, § 6(s).  See, e.g., Letter Rulings 05-2; 10-3; 10-4, and the authorities cited therein.  In construing the direct and exclusive use requirement of § 6(s), the Commissioner has recognized that a use that is de minimis will not defeat the exclusivity requirement for exemption.  Whether a use is de minimis shall be determined by the Commissioner based on the facts and circumstances of a taxpayer's overall operations. 

We note that under the specific facts provided, the software incorporated into the Energy Storage System serves a number of purposes, many of which are critical to the operation and management of the Energy Storage System.  In particular, the software provides the capability to monitor and control the Energy Storage System remotely or locally.  It is used to control the discharge of the battery, including the amount of power and duration of the discharge, and will allow the operator to schedule dispatch of the battery locally in the event that connectivity with the cloud-based software is lost.  The software also allows the user to optimize the function of the Energy Storage system to improve performance and adapt to weather and workflow changes.  The software is also used for "behind the meter uses" including customer services such as reducing consumption of energy drawn from the grid during periods of peak demand by discharging energy from the battery for consumption by the customer.  We find that these uses of the Software are primarily activities used in furnishing electricity to consumers.

We also note that the Software has other functionalities not critical to the furnishing of electricity to consumers.  Lessee’s use of the software enables it to collect and make available to Utility Company various information and metrics related to the performance of the Energy Storage System.  It also enables Lessee to use the information for federal tax credit metrics purposes.  We find that these particular uses are de minimis in relation to the exempt use to which the software is put as a whole.  As such, these uses do not defeat the exclusive use requirement of the furnishing clause of G.L. c. 64H, § 6(s).  Accordingly, we conclude that the Software meets the requirement that it be used directly and exclusively in furnishing electricity to consumers.

We emphasize the limits of our conclusion on this issue.  This conclusion does not imply that any software that may qualify as an “adjunct” to exempt machinery automatically qualifies for exemption under G.L. c. 64H, § 6(s). In order to be exempt, software must meet all the remaining requirements of the § 6(s) exemption, based on all of the facts and circumstances. 

C.  Sale/Leaseback of Energy Storage System

1.  Sale to Lessor

Under G.L. c. 64H, § 6(c), "casual and isolated sales by a vendor who is not regularly engaged in the business of making sales at retail" are exempt from sales tax.  Casual and isolated sales are "sales of items of tangible personal property originally acquired for use or consumption by a seller and later sold by that seller other than in the regular course of a business engaged in by that seller."  830 CMR 64H.6.1, Casual and Isolated Sales.  You have indicated that upon completion of the construction of the Energy Storage System, Lessee will own the system.  You further indicate that shortly after Lessee acquires ownership, Lessee will sell the system to Lessor and immediately lease the system back from Lessor in a sale/leaseback transaction.  You assert that Lessee is in the business of operating power plants, that it will acquire the Energy Storage System for its own use, and that its sale of the Energy Storage System to Lessor will not be in the regular course of its business.  Therefore, you propose that Lessee's sale to Lessor of the Energy Storage System be exempt from sales tax as a casual and isolated sale. You cite Letter Ruling 86-9 (Sale-Leaseback of Equipment) in support of this proposal. 

Letter Ruling 86-9 addressed the application of the Massachusetts sales tax to a sale-leaseback of communications equipment purchased by a utility company. The utility company was primarily engaged in the distribution of a utility (not telecommunications services) to commercial and residential customers.  When title to the equipment passed to the utility company, the utility company presented a resale certificate to the vendor, who refused to accept the certificate because the utility company did not intend to resell the communications equipment in the regular course of business. Under those facts, the Commissioner concluded that the vendor could not accept  a resale certificate from the utility company because the utility company was not engaged in the business of selling communications systems, and the utility company did not intend to sell the communications system it purchased in the regular course of business.  A resale certificate relieves the vendor of proving that a sale of tangible personal property is not a retail sale if the vendor takes the certificate in good faith from a person who is engaged in the business of selling the tangible personal property in the regular course of business.  See G.L. c. 64H, § 8(b).  Although the Commissioner concluded that the sale of the communications was not exempt as a sale for resale, he also concluded that the sale was exempt as a casual and isolated sale under G.L. c. 64H, § 6(c).

Here, we note that Lessee is in the business of operating power plants, not selling energy storage systems. It acquired the Energy Storage System for its own use and its sale of the system to Lessor was not in the regular course of business. Accordingly, under the rationale of Letter Ruling 86-9, we find that the sale by Lessee to Lessor is exempt from sales tax as a casual and isolated sale. 

2.  Leaseback by Lessee

Based on the facts you have presented, shortly after Lessee acquires the Energy Storage System, Lessee will sell the system to Lessor and immediately lease the system back from Lessor in a sale/leaseback transaction.[8]  You further indicate that Lessor and Lessee intend, for federal income tax purposes, that Lessor be treated as the owner and that the lease between Lessor and Lessee be respected as a true lease.  A lease of tangible personal property is generally subject to the sales tax, unless an exemption applies.  G.L. c. 64H, § 2.  Here, we find that the leaseback of the Energy Storage System from Lessor to Lessee is exempt as a sale (or lease) of machinery used directly and exclusively in the furnishing of electricity to consumers through mains, lines, or pipes under G.L. c. 64H, § 6(s). See Section V.A., above.

VI. Conclusion

Based on the facts provided and for the reasons set forth above, we rule that, with the exception of the protective containers described in Section II.B.1.(b), the items listed in Section II.B.1., qualify as exempt machinery that is used directly and exclusively in furnishing electricity that is delivered to consumers through mains, lines or pipes.  We also rule that the Software described in Section II.B.2. is not custom computer software and is not exempt from sales tax as such.  However, we rule that the sale or licensing of the Software to Lessee by the Information Service Provider is exempt under the "furnishing clause" of G.L. c. 64H, § 6(s).  Finally, we rule that the sale of the Energy Storage System is exempt from sales tax as a casual and isolated sale.  The subsequent leaseback of the Energy Storage System from Lessor to Lessee is exempt as a lease of machinery used directly and exclusively in furnishing electricity to consumers through mains, lines, or pipes.

                                                                    Very truly yours,

                                                                    /s/Christopher C. Harding

                                                                    Christopher C. Harding
                                                                    Commissioner of Revenue

CCH:RFH:wrd

LR 18-3

[1] In addition, under G.L. c. 64H, § 6(r), sales of materials, tools and fuel, or any substitute therefor "... which are consumed and used directly and exclusively... in the furnishing of gas, water, steam or electricity when delivered to consumers through mains, lines, or pipes... " are exempt from sales tax.

[2] See, e.g., Letter Rulings 16-2, (Sales of Pollution Control Equipment for Use in Operation of Electricity Generation and Distribution Plant); 11-7, (Sales Tax on Photovoltaic Solar Energy System); 10-4, (Sales Tax Exemption for Anaerobic Digestion System); 10-3, (Sales Tax on Machinery Used To Construct, a Wind Turbine); 06-5 (Supplement to Letter Ruling 05-2), 05-2, (Water Desalination Plant); See also, generally, LR 01-6 (Sales Tax Treatment of Certain Clean Room Equipment)(addressing the sales tax treatment of certain machinery under an independent clause of G.L. c. 64H, § 6(s) exempting machinery  used in “the furnishing of power to an industrial plant”); and the authorities cited therein.

[3] See Letter Ruling 10-3, citing Letter Ruling 05-2; Ace Heating Service, Inc. v. State Tax Commission, 371 Mass. 254, 256 (1976); Letter Ruling 84-85 (Steam and Electricity Generating Plants) and the authorities cited therein.

[4] See, e.g., Research and Development regulation, 830 CMR 64H.6.4(9)(b); Letter Rulings 16-2; 10-4 and 05-02; Directive 99-8 (Cranberry Growers-Sales and Use Taxes on Equipment Used in Production).

[5] See LR 16-2 and further authorities cited therein.

[6] See also Letter Ruling 05-2, citing Tennessee Gas Pipeline Co. v. Commissioner of Revenue, A.T.B. Docket Nos.171876-171879 and 194866-194869 (1998)

[7] With respect to the sale/leaseback transactions at issue, we have reached the conclusion that the original transaction – the sale of equipment and software to Lessee for the operation of the Energy Storage System involves the sale of “standardized software” not “custom software.”  Therefore, the original sale or license to Lessee for the software that comprises the software platform is a sale of standardized software, and is taxable unless exempt under a particular provision of law.  Even if we were to conclude that the software is custom software, we note that once it is sold to Lessor for the purpose of being leased back by Lessee as part of a sale/leaseback transaction, it would not retain its character as custom software.  “Custom software development is a professional service transaction.”  830 CMR 64H.1.3(6)(a),(b).  However, once the software is developed and sold to Lessor as part of a sale-lease-back transaction, it loses its characterization as custom software.  “If custom software sold to a single purchaser is later sold to others, the later sales are sales of prewritten software.”  830 CMR 64H.1.3(6)(f).

[8] While this ruling does not address whether the sale/leaseback transaction is considered to be a financing arrangement, we note that where the facts and circumstances indicate that a sale and leaseback transaction is merely a financing arrangement, and neither title nor possession transfer to the financing agency, the Commissioner has indicated that in those circumstances, the Department will treat a sale and leaseback transaction as a nontaxable financing arrangement.  See Letter Ruling 99-9 (Sale Lease-Back), citing Letter Ruling 96-6 (Is a Sale and Leaseback Financing Transaction Subject to Massachusetts Sales Tax?). 

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